World's Best Dividend Portfolio

In June 2011, I announced to Fool.com readers that I was putting $10,000 of my own money to work in 10 income-producing stocks. The stocks yielded 6% -- more than triple the average S&P 500 stock, gushing cash back to us shareholders. How did that turn out?

To be blunt, it was a smashing success. The portfolio returned 10.5%, compared to just 5.5% for the S&P. In other words, we nearly doubled the S&P's performance. Readers followed along all year with my weekly performance reports, and we collected dividends month after month, and then squirreled that money away in our dividend payers.

I'm looking to do it again this year, as I add new money and a few more stocks to what I call the World's Best Dividend Portfolio.

Read on to find out where my money's going, because the time to act is now.

Why dividends?Dividend stocks offer a solid payout and lower volatility than their non-paying cousins. In practice, that means dividend stocks outperform in bear markets and tend to underperform in raging bull markets but, all the while, they keep gushing those dividends. This approach is backed by tons of studies.

Researchers at Tweedy, Browne surveyed the investment literature over decades, and determined that high-yield stocks do well. Or, as Tweedy dryly notes: "There is substantial empirical evidence to support a direct correlation between high dividend yields and attractive total returns." And dividend stocks did well relative to other strategies: "At least one study found that high dividend yield stocks outperformed other value strategies as well as the overall stock market return in declining markets."

They had me at "high dividend yields and attractive total returns."

We've already seen a taste of those benefits in the World's Best Dividend Portfolio, though it's only been a year. Now we're forging ahead with a few new stocks, and more money.

Here are the stocks I selected last year, our performance through June 28, and those tasty yields. I put $1,000 in each to start.

Company

Yield

Total Value

Return

Southern

4.2%

$1,170.32

17.5%

Exelon

5.6%

$1,077.79

(9.6%)

National Grid

5.8%

$1,070.20

7.4%

Philip Morris International

3.6%

$1,245.16

25.0%

Annaly Capital

13.2%

$1,089.92

(7.1%)

Frontier Communications

10.6%

$479.15

(51.9%)

Plum Creek Timber

4.4%

$1,010.88

1.2%

Brookfield Infrastructure Partners

4.5%

$1,274.81

27.5%

Vodafone

5.0%

$1,059.47

6.4%

Seaspan

5.7%

$1,340.64

18.4%

Cash

$88.11

Dividends Receivable

$90.40

Original Investment

$9,986.58

Total Portfolio

$11,032.88

10.5%

Investment in SPY

(including dividends)

5.5%

Relative Performance

(percentage points)

5

We had seven of 10 stocks with positive performance - and that's before you count dividends that are now 5.9% on average! And don't let those negatives next to Annaly (NYS: NLY) and Exelon get you worked up. With Annaly's double-digit yield, it ended in positive territory for the year. Exelon provided a small loss after you factor in its 5%+ yield, but I'm willing to wait on it at this price.

I'm still confident in these stocks, with one exception. The only real loser was Frontier (NYS: FTR) , which slashed its dividend and cut its estimate of free cash flow for 2012. I'll be selling Frontier when I think it reaches a reasonable price and reinvesting those proceeds.

But here's the big news...

The new ground rulesThis year, I'm adding $3,000 to the portfolio to help simulate an investor who socks away more money each year. I'm picking three new dividend stocks that each yield at least double the S&P, and putting $1,000 in each. Here they are:

AT&T provides a better positioned telecom to replace the outgoing Frontier. Its yield is sustainable, despite its high payout of free cash flow, at 71%. AT&T has a strong competitive position in mobile among what's effectively a triopoly with Verizon and Sprint, and AT&T's size ($211 billion market cap) means it has greater financial resources to continue its payout.

I've touted the virtues of Retail Opportunity Investments Corp (ROIC, for short) in this article, but they bear repeating. The company is a small-cap ($617 million), and with the acumen and business relationships of CEO Stuart Tanz, it is bound to grow. This REIT's dividend has doubled since its initiation in early 2010, and that growing portfolio of properties will lead to a greater dividend over time. ROIC will diversify the portfolio with more direct exposure to real estate.

I'm picking up shares in the new Series C shares of Annaly for a couple reasons. First, they offer a high yield, $1.91 per year, or 7.5%. Second, we still get access to the Annaly's well-run business without the same risk of capital depreciation, should interest spreads decline. Sure, preferreds have interest rate risk, but we'll be buying only slightly above the par value of $25, and we have nearly five years until they can be called. We'll still get paid a tasty dividend without the problem of having to guess when Annaly might start to get hurt by rates.

Like last year, I'll keep these stocks in my portfolio for at least a year and will notify you of any changes (such as dividend reinvestments) before I make them.

Join meI'm so confident that this portfolio will do well, that I'm adding my own money next week, as soon as the Fool's trading rules permit. I'll be reinvesting these fat dividends into more stocks in the portfolio, and you can follow along every week as I provide updates, news, and dividend announcements. I plan to turn this high-yield portfolio into a true dividend dynamo that gushes cash month after month. It's time to act.